On December 4, 2017, the U.S. Securities and Exchange Commission (“SEC”) approved the New York Stock Exchange’s (the “NYSE”) proposed rule change to amend Section 202.06 of the NYSE Listed Company Manual to prohibit listed companies from releasing material news after the NYSE’s official closing time until the earlier of the publication of such company’s official closing price on the NYSE or five minutes after the official closing time. The new rule means that NYSE listed companies may not release end-of-day material news until 4:05 P.M. EST on most trading days or until the publication of such company’s official closing price, whichever comes first. The one exception to the new rule is that the delay does not apply when a company is publicly disclosing material information following a non-intentional disclosure in order to comply with Regulation FD. Regulation FD mandates that publicly traded companies disclose material nonpublic information to all investors at the same time.
On 14 November 2017, the Monetary Authority of Singapore (the “MAS”) released “A Guide to Digital Token Offerings” providing general guidance on the application of the securities laws administered by the MAS in relation to offers or issues of digital tokens in Singapore.
The main consideration is whether the digital token is designed in a way that would make it a product regulated under Singapore’s securities laws i.e. if it behaves like a share, debenture or some other form of security. If a token does not function like a security, then technically, neither will the security laws apply.
In the first case study in the guide, Company A plans to set up a platform to enable sharing and rental of computing power amongst the users of the platform. In order to raise funds to develop this platform, Company A intends to offer and sell digital tokens wherein the token will have utility upon completion. The MAS states that the digital token in this case study would not constitute a security under the Securities and Futures Act (Cap. 289). It appears that this is because other than the right to access the issuer’s platform to rent computing power, the digital token in question did not appear to have any other “rights” or “features” that made it look like a security.
Therefore, if a digital token is structured in a similar way as set out in this case study, then it would presumably not trigger the relevant Singapore securities laws, notwithstanding the fact that the sale of the token may have been used to fund the building of the platform.
The practical issue to consider then is this:- How will a company convince its investors to purchase such digital tokens in the first place, given that they do not appear to offer any type of rights or features that would give potential purchasers of those digital tokens a return on their investment?
Singapore is devoting huge resources to building the FinTech industry and offering many incentives to new entrants in the jurisdiction. Initial Coin Offerings (“ICOs”) structured like the example herein would seem to be acceptable.
Efforts to conserve an equity plan’s share reserve should begin the day the issuer’s stockholders approve the plan (or share increase), and should continue going forward. Issuers that do not make such efforts tend to face problems relating to dwindling share reserves, including moving to cash-based programs, hiring proxy solicitation firms to garner stockholder support for share increases, and overcoming possible negative reactions from ISS.
- Grant awards that are settled in cash – Depending on the terms of the plan, a cash-settled award may not draw from the share reserve.2 An alternative would be settling a portion of the award in shares (e.g., up to target), with any achievement above that settled in cash.
- Grant full value awards like restricted stock or RSUs – Such grants provide greater value to the holder than options or SARs, the latter providing incentive only to the extent the share price exceeds the exercise/strike price, but draw from the share reserve the same as full value awards.3
- Permit net-exercise of stock options – Depending on the terms of the plan, the shares subject to the option that are netted in a net-exercise may not draw from the share reserve. Also, a net-exercise could be helpful to a Section 16 insider to avoid a blackout (i.e., no open market transaction occurs with a net-exercise).4
- Amend the plan to permit maximum withholding – A recent change in accounting rules provides that maximum withholding will not result in liability accounting treatment. Depending on the terms of the plan, withholding of shares to cover taxes may not draw from the share reserve.
- Grant stock-settled SARs rather than options – A stock-settled SAR will provide the same economic result as a net-exercised option, but since a SAR is settled in shares with respect to only the excess over the strike price, fewer shares are burned than with a net-exercised option.
- Use inducement awards for new executive-level hires and certain M&A events – The award must be a material inducement to getting the executive/employee to accept the position. If properly structured, these awards can be made outside of the plan and do not require stockholder approval under NYSE or NASDAQ rules.5
- Implement an ESOP or ESPP – ESOPs, which are subject to ERISA, do not require stockholder approval under NYSE or NASDAQ rules. Depending upon the structure of an ESPP, stockholder approval may be required.6
1. Some of these methods involve liberal share counting, which is disfavored by ISS.
2. Liability classification would apply for accounting purposes and settlement in cash will not count towards satisfying any share ownership requirements.
3. This method will not work if the plan contains fungible share counting provisions.
4. However, a net-exercise of an incentive stock option could jeopardize the ISO’s favorable tax treatment.
5. Without stockholder approval, such awards could not qualify for deduction under Section 162(m), if applicable.
6. Broad participation requirements may apply.
In the days following the November elections, U.S. President-elect Donald J. Trump promised that his Financial Services Policy Implementation team would be working to “dismantle” the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”). However, a more recent account in the Wall Street Journal reported Mr. Trump’s transition team as tempering his promise in favor of rescinding or scaling back the individual provisions Republicans find most objectionable.
In light of the current political and macro-economic environment, here are six reasons why a wholesale repeal of Dodd-Frank is unlikely to occur:
Congressional Resistance – A wholesale repeal of Dodd-Frank would have to be effectuated through congressional action and would likely face a democratic filibuster. This would require opponents of Dodd-Frank to muster a 60-vote block in the Senate in order to advance the proposal. Legislative horse-trading to achieve specific objectives that are key to the Republican majority may ultimately prove to be more strategically advantageous.
Public Perception – Actions of the new administration which could be perceived as advocating for easing the burden on the financial services industry may alienate the middle-class constituency who were significantly impacted by the great recession and who ultimately propelled Mr. Trump to the Presidency.
Balance of Cost – Following massive investments in infrastructure and processes, the industry may perceive the costs of undoing the compliance programs put in place subsequent to Dodd-Frank as outweighing the benefits to be derived from decreased regulation.
Accepted Expectations – Counterparties have come to accept the safeguards and reporting requirements put in place by Dodd-Frank as constituting baseline expectations in business transactions. A repeal of Dodd-Frank would leave industry participants to reconstruct by contract what may have been previously mandated under law.
International Developments – In the wake of the Brexit vote, international financial organizations may be evaluating the relocation of their operational centers to locations in the U.S. The possibility of significant financial regulatory overhauls and the accompanying specter of an unknown business environment may dissuade consideration of the U.S. by such organizations.
Absence of a Perceptible Problem – Dodd-Frank was passed on July 21, 2010 with the wake of the great recession providing momentum and popular support for its enactment. Conversely, there is no corresponding economic situation presently existing that critics can point to for its repeal. The DJIA is up approximately 90% since July 2010. The real estate market has remained strong and, even with the recent increase by the Fed, interest rates remain low, allowing consumers access to both homeownership and financing on attractive terms.
In addition to the issues identified above, the incoming Presidential administration and congressional delegation may face additional hurdles in advancing comprehensive legislative initiatives to pare back Dodd-Frank. As the post-election environment cools and the country marches towards inauguration day, the financial services industry can only hope that clarity on the direction of the U.S. regulatory environment begins to emerge.
In the days following the U.S. federal elections that resulted in the election of Donald Trump as President and Republican control of the 115th Congress, FinTech companies, banks, and other financial institutions are increasingly asking whether they still need to worry about compliance with the landmark Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”), Consumer Financial Protection Bureau (“CFPB”) regulatory actions, and other financial services regulations.
It is true that there will likely be some significant regulatory changes, but it is a little too early for industry participants to pop the champagne corks. Here are our thoughts about some of the top issues impacting FinTech companies, banks, and other financial institutions:
Dodd-Frank and the CFPB
Created under Dodd-Frank in response to the financial crisis of 2007–2008, the CFPB’s stated aim is “to make consumer financial markets work for consumers, responsible providers, and the economy as a whole.” Since its inception, the CFPB has regulated the consumer financial services marketplace through sweeping rulemakings, including the recent issuance of a long-awaited final rule for prepaid accounts. Precedent-setting enforcement actions also have been increasingly utilized by the CFPB in lieu of, or as a precursor to, rulemakings promulgated in accordance with the Administrative Procedure Act. Policymakers, banks, and others within the broader financial services industry have criticized the CFPB for regulatory overreach and for imposing burdensome, duplicative regulations on market participants that ultimately impact on consumer choice.
It is no surprise, therefore, that revising the CFPB’s structure and operations to try to make the agency more transparent and accountable is among the top priorities of both the incoming Administration and Congress as part of reform of Dodd-Frank. Some version of House Financial Services Committee Chairman Jeb Hensarling’s (R-TX) financial reform legislation (H.R. 5983, the “Financial CHOICE Act” or “FCA”), will undoubtedly serve as a basis for any reform efforts undertaken in the early days of the Trump Administration and the new Congress. Although the CFPB will likely survive in the new Administration and Republican-led House and Senate, the FCA furnishes a blueprint for the kinds of reforms that likely will be made.
The FCA contains provisions that would make significant modifications to the structure of the CFPB by making it an independent agency outside of the Federal Reserve to be headed by a five-member commission, instead of a single director. The FCA would rename the CFPB the “Consumer Financial Opportunity Commission” and would give the agency the mission of consumer protection and competitive markets. The FCA would also subject the CFPB’s funding to the Congressional appropriations process. The FCA also includes provisions designed to address the CFPB’s use of enforcement actions by repealing the agency’s authority over “abusive practices” in the consumer financial services industry. In addition, the FCA also contains H.R. 5413, the “CFPB Data Accountability Act,” which would require the CFPB to verify a consumer complaint prior to posting it on the CFPB’s website.
The FCA also contains a provision that would repeal the “Durbin Amendment,” which limited the interchange fees that banks charge merchants to process electronic debit transactions. Following enactment of Dodd-Frank, many payments industry participants raised concerns that small banks and low-and moderate-income consumers have been adversely impacted by the Durbin Amendment, while retailers have disproportionately benefited. Given the anticipated focus of the Trump Administration and new Congress on the promotion of financial market innovation and competitiveness, it is increasingly likely that changes to this provision could be considered as part of broader financial regulatory reform efforts. Whether it will be entirely repealed is another question. Merchants, who fought hard for the Durbin Amendment by arguing that the high fees imposed by major banks and the payment networks were unfair, can be expected to vigorously oppose such an effort.
The regulatory outlook for the CFPB for the near future will likely be impacted by a number of important factors, including the outcome of the CFPB’s recent petition to the U.S. Court of Appeals for the District of Columbia Circuit (“D.C. Circuit”), which requested the full D.C. Circuit to rehear PHH Corp. v. CFPB. The petition follows the recent holding in PHH by a three-judge panel of the D.C. Circuit that the CFPB’s existing structure is unconstitutional and that the director of the CFPB serves at the pleasure of the President. President-elect Trump currently has the ability to remove current CFPB Director Richard Cordray “for cause” and to nominate a replacement to be confirmed by the Senate. Such a change in the director of the CFPB before the D.C. Circuit makes a decision on whether to rehear PHH could have significant implications for the CFPB’s regulatory activities. Republicans in the 115th Congress also are expected to use the Congressional Review Act (“CRA”) to repeal certain regulations recently issued during the Obama Administration. However, many of the CFPB’s rules are expected to remain in place but be subject to additional Congressional scrutiny. Notably, some Congressional Republicans have previously expressed concerns about the broad scope of the CFPB’s rule on prepaid accounts, although it is not yet clear whether the rule will be among the regulations that could be the focus of repeal efforts through use of the CRA. Additionally, Congressional Republicans will likely subject the CFPB’s operations to heightened oversight and will probably seek to repeal the agency’s authority to prohibit arbitration agreements and to issue guidance related to indirect automobile lending.
Enforcement Outlook Generally
Although the CFPB’s activities may be reduced through reformation of the agency or an appreciable change in its leadership, such changes are also likely to be accompanied by heightened regulatory and enforcement efforts by state government officials and an increase in efforts by consumers to seek redress in the courts. Anticipating that the incoming Administration could result in a reduction of enforcement activities against banks and financial institutions at the federal level, many state attorneys general are indicating that they will step into the vacuum to protect consumers if necessary. It has been widely reported, for example, that both New York and California attorneys general intend to fill any regulatory enforcement void created by the incoming Administration. Nevertheless, a shift in the CFPB’s enforcement priorities may have a lasting impact on financial institutions and financial markets.
Going forward, payments companies and other consumer financial services industry participants should certainly monitor changes in laws, regulations, and enforcement actions closely as they seek to better understand these changing legal and regulatory dynamics and the nature of the regulations with which they will be required to comply.
 See, Eric A. Love, Judith Rinearson and Linda C. Odom, CFPB Finalizes Expansive Prepaid Account Rule Creating New Compliance Hurdles, K&L Gates Legal Insight, (Nov. 2016), https://www.fintechlawblog.com/wp-content/uploads/2016/11/FinTech-blog-4….
 See, e.g., Press Release, House Financial Services Committee, Who will protect consumers from the overreach of the Consumer Financial Protection Bureau? (Mar. 3, 2015), http://financialservices.house.gov/news/documentsingle.aspx?DocumentID=3….
 See, Respondent Consumer Financial Protection Bureau’s Petition for Rehearing En Banc, No. 15-177 (D.C. Cir. Nov. 18, 2016) (Doc. #1646917).
 See, PHH Corp. v. Consumer Financial Protection Bureau, No. 15-1177 (D.C. Cir. Oct. 11, 2016).
 See, e.g., Joel Stashenko, Trump Presidency Could Shift Regulatory Spotlight to State and AG, N.Y. Law Journal, Nov. 14, 2016.
As a result of both legislative mandates as well as Congressional and public concern, the Board of Governors of the Federal Reserve System (Board) has been examining whether to impose new restrictions on the activities of banks related to physical commodities. Following these examinations, the Board recently took two actions designed to impose new limits on the activities of banks related to physical commodities: (i) a notice of proposed rulemaking to impose new capital requirements and other limits on such activities of financial holding companies (FHCs) (the “proposed rule”); and (ii) a report, issued pursuant to Section 620 of the Dodd-Frank Act (620 Report), which contains recommendations for legislation to repeal several current authorities for banks to engage in physical commodities activities.
Proposed rule. In brief, the proposed rule would:
- increase the capital requirements for activities of FHCs involving commodities for which existing laws would impose liability if the commodities were released into the environment;
- lower the limit on the amount of physical commodities that may be held by banks that conduct commodity trading activities;
- rescind authority for banks to engage in energy tolling and energy management services;
- delete copper from the list of precious metals that BHCs are permitted to own and store; and
- establish new public reporting requirements on the nature and extent of firms’ physical commodities holdings and activities.
620 Report. The 620 Report is divided into three sections, by federal banking regulator. Section I, prepared by the Board, covers state member banks, depository institution holding companies, Edge Act and agreement corporations, and US operations of foreign banking organizations. In its section, with respect to physical commodities, the Board recommends legislative action that would:
- repeal the authority of FHCs to engage in merchant banking activities; and
- repeal the grandfather authority for certain FHCs to engage in commodities activities under section 4(o) of the Bank Holding Company Act (BHCA).
Although participants in energy and other physical commodity markets have commented to the Board that the imposition of new capital requirements and other restrictions on bank participation in physical commodity markets could reduce liquidity and increase costs for end users, the Board has nonetheless proceeded with the proposed rule and legislative recommendations. The Board estimates that the proposed rule will not have a significant impact on the physical commodity markets or the related derivative markets.
In this article, we summarize and provide key takeaways from the proposed rule and the 620 Report.
The Proposed Rule
Prior to 1999, BHCs were generally barred from participating in “commercial” activities and had very limited authority to engage in physical commodities activities. Pursuant to the BHCA, BHCs could undertake only those commodities activities that were “so closely related to banking as to be a proper incident thereto,” such as buying, selling and storing precious metals and copper, or acting as principals in cash-settled commodities derivative contracts.
The Gramm-Leach-Bliley Act (GLBA) amended the BHCA by allowing BHCs with well-capitalized bank subsidiaries to expand the scope of their activities with respect to commodities. Specifically, three key provisions gave BHCs greater opportunities in this area: (1) the complementary authority under BHCA section 4(k), which allows FHCs to engage in any activity deemed by the Board to be “complementary to a financial activity”; (2) the merchant banking authority, which allows FHCs to invest in nonfinancial companies that engage in commodities activities that FHCs themselves are not permitted to undertake; and (3) the grandfather clause authority under BHCA section 4(o), which permits certain institutions that were conducting physical commodities activities prior to becoming FHCs to engage in a broad range of physical commodities activities, including those beyond the scope of both the complementary and the merchant banking authorities.
To date, the Board has approved three types of complementary activities: (i) physical commodities trading, which includes taking delivery of commodities under derivative contracts and buying and selling in the spot market; (ii) energy management services, such as providing advisory services to or arranging transactions for power plant owners; and (iii) energy tolling agreements, under which firms pay power plant owners fixed payments in exchange for the rights to plant output.
Advance Notice of Proposed Rulemaking. In January 2014, the Board issued an Advance Notice of Proposed Rulemaking to review the scope of physical commodities activities currently permitted by law, and determine whether such activities pose significant risks to the safety and soundness of insured depository institutions or the financial system generally, and whether additional limits or requirements should be imposed on the banks conducting these activities.
Senate testimony on rulemaking. In November 2014, Federal Reserve Board Governor Tarullo testified to Congress that the Board would be issuing a notice of proposed rulemaking and was considering whether to impose more stringent overall caps on complementary and merchant banking activities, as well as stricter capital requirements by increasing the risk weighting for physical commodities activities associated with catastrophic or environmental risks.
On September 23, 2016, the Board issued a proposed rule to (i) adopt new limits on physical commodities trading activity conducted by FHCs under the complementary authority; (ii) impose new risk-based capital requirements on FHC physical commodities activities; (iii) rescind the authorizations for FHCs to engage in energy management services and energy tolling; (iv) remove copper from the list of precious metals that BHCs are permitted to own and store as an activity closely related to banking; and (v) impose new public reporting requirements to increase transparency into physical commodities activities of FHCs.
The higher capital requirements would be imposed through new proposed risk weights for the various types of permissible commodities activities.To determine the risk-weighted asset exposure for covered physical commodities, these proposed risk weights would be multiplied by (i) the market value of all section 4(o) permissible commodities; (ii) the original cost basis of section 4(o) infrastructure assets; (iii) the market value of section 4(k) permissible commodities; and (iv) the carrying value of an FHC’s equity investment in companies that engage in covered physical commodities activities.
The proposed rule would affect each of the GLBA authorities as follows:
New risk-based capital requirements. A 300% risk weight would apply to physical commodities holdings permissible under complementary physical commodities trading activities. The proposed requirements would apply with respect to physical commodities that are substances covered under federal or relevant state environmental statutes and regulations (“covered physical commodities”). According to the Board, “These physical commodities carry the greatest potential liability under relevant environmental laws.” The Board states that this would provide a level of capitalization for these activities that is “roughly comparable to that of nonbank commodities trading firms.”
Tighten the cap on physical commodities holdings. In order to limit the aggregate risks from physical commodities trading activities that an FHC may face, the limit placed on physical commodities holdings of FHCs under complementary authority (5% of tier 1 capital) would also take into account physical commodities held anywhere in the FHC, subject to a few exceptions. The ability of an FHC to undertake or expand its physical commodities activities under the complementary authority therefore would be constrained by the extent to which the FHC and its subsidiaries engage in physical commodities activities under other authorities.
Clarify prohibition on operations. The proposal would codify in the Board’s Regulation Y the prohibition on owning, operating or investing in facilities for the extraction, transportation, storage or distribution of commodities under the complementary authority. It also would clarify that this prohibits directing the operations of third-party extraction, storage or transportation providers. The proposed list of restrictions is not intended to be exhaustive; the Board states that the purpose of this proposal is to ensure that FHCs refrain from activities related to physical commodities that could impose environmental liability upon the FHC.
Rescind authority for energy management services and tolling. Energy management services and tolling would no longer be permitted under complementary authority. According to the Board, the proposal would affect the actual activity of only one firm and the authority of five FHCs. The Board states that the fact that only one firm is now engaging in these activities indicates that the activities are not “as directly or meaningfully connected to a financial activity as is physical commodities trading,” and that the expected benefits from permitting these activities have not materialized. The Board mentions that the rescission of these authorities would not affect the ability of FHCs to provide derivatives and related financial products and services to power plants or engage in physical trading. The proposal provides a two-year transition period to conform to these new restrictions.
Merchant banking authority
New risk-based capital requirements. The proposal would apply a 1,250% risk weight to a merchant banking investment in a company engaged in physical commodities activities unless all of the physical commodities activities of the portfolio company are permissible under complementary authority (e.g., physical commodities trading). If all the physical commodities activities of the portfolio company are permissible under complementary authority, then: (i) a 300% risk weight would apply to the investment if the company is publicly traded (the same risk weight that would apply to physical commodities trading activities conducted under the complementary authority); and (ii) a 400% risk weight would apply if the company is not publicly traded (this is intended to be consistent with the standardized approach to equity exposures).
The capital requirements would not apply to certain end user physical commodities activities where the portfolio company uses covered physical commodities to operate businesses otherwise unrelated to physical commodities. The proposed capital requirements would not apply to a merchant banking investment solely because the portfolio company owns or operates a facility or vessel that purchases, stores, or transports a covered physical commodity only as necessary to power or support the facility or vessel.
The Board explains that these risk weights are designed to address the risks from merchant banking investments generally, “the potential reputational risks associated with the investment, and the possibility that the corporate veil may be pierced and the FHC held liable for environmental damage caused by the portfolio company.” In the Board’s view, a higher risk weight for privately traded portfolio companies is warranted because an FHC “may not be able to gain access to markets for a privately held portfolio company after an environmental catastrophe” involving that company.
New risk-based capital requirements. A 1,250% risk weight would apply to physical commodities and related assets (e.g., infrastructure assets) permitted to be owned solely under the statutory grandfather provision. This risk weight would be applied to the market value of all commodities permitted to be held only under the grandfather authority, as well as to the original cost basis of section 4(o) infrastructure assets.
A 300% risk weight would apply to activities that are conducted under the grandfather provision or through merchant banking authority but that are also permissible under complementary authority. The 300% risk weight would apply only, however, to the extent that the market value of the amount of physical commodities held under this authority, when aggregated with the market value of other physical commodities owned by the FHC that the proposal would not already subject to a 1,250% risk weight, does not exceed 5% of the consolidated tier 1 capital of the FHC.
The Board states that the 1,250% risk weight, which is the highest risk weight currently specified by the Board under its standardized approach, is “intended to address the risk of legal liability resulting from the unauthorized discharge of a covered substance in connection with the infrastructure asset.” The Board notes that this risk weighting is not intended to require capital against the full potential liability that might result from a catastrophic event, but rather is intended to reflect “the higher risks of physical commodity activities permissible only under section 4(o) grandfather authority without also making the activities prohibitively costly by attempting to capture the risks of the largest environmental catastrophes.”
Reclassification of copper
Copper would be deleted from the list of precious metals that BHCs are permitted to own and store for their own accounts or the accounts of others. The Board explains that although in 1997 copper was added to the list that included gold, silver, platinum and palladium bullion, coins, bars and rounds, over time copper has “become most commonly used as a base or industrial metal, and not as a store of value in the same way as gold, silver, platinum, and palladium.” The Board notes, and we discuss below, that the Office of the Comptroller of the Currency (OCC) has recently proposed a similar reclassification of copper under the National Bank Act.
The proposed rule would impose new public reporting requirements for commodities holdings of FHCs in order to increase transparency, allow better monitoring by regulators and improve firm management of these activities. The proposed rule would require the reporting of the total fair values of various commodities held in inventory, as well as the risk-weighted asset amounts associated with an FHC’s covered physical commodities activities, section 4(o) infrastructure assets or investments in covered commodity merchant banking investments.
FHCs also would be required to identify whether they own any covered physical commodities, any section 4(o) infrastructure assets or any investments in covered commodity merchant banking investments; whether they are engaged in the exploration, extraction, production or refining of physical commodities; and whether they own facilities, vessels or conveyances for the storage or transportation of covered physical commodities. Further, FHCs would be required to report the total fair value of section 4(k)- and section 4(o)-permissible commodities owned, the original cost basis of any section 4(o) infrastructure assets, and the carrying value of investments in covered commodity merchant banking investments.
Board analysis of impacts
The Board believes the proposal will not have a material impact on the markets for physical commodities or derivative instruments related to those commodities. According to the Board, the amount of additional capital required to be held by FHCs under the proposal would be approximately $4.1 billion in the aggregate. The Board estimates the proposal would result in an “insignificant” increase of 0.7% in total risk-weighted assets and a 7.1% increase in risk-weighted assets attributable to trading business. The Board concludes that, among FHCs that engage in physical commodities activities, this increase in risk weighting “would not cause any FHC to breach the minimum capital requirements.”
The Board observes that “if FHCs consider their physical commodities trading on a standalone basis, the proposed increases in capital requirements could make this activity significantly less attractive based on its return on capital, and could result in decreased activity.” The Board states, however, that such a reduction in activity “is not likely expected to have a material impact on the broader physical commodity markets.”Although the Board acknowledges that information on the markets covered by the proposal is “relatively scarce,” the Board states that it appears that Board-regulated entities account for a small fraction of the physical markets for these commodities.
Using data from the Commodity Futures Trading Commission’s (CFTC’s) Bank Participation Report, the Board finds that the market share of banks in derivative contracts involving physical commodities ranges from 2% to 15% and therefore that any reduction in bank activity in these financial markets that might result from the proposal “should not materially impact” these derivative markets. The Board also estimated that, in light of the relatively small share of FHCs in the commodity markets, the impact of the proposed increase in capital requirements upon merchant banking investment activities “appears insignificant.”
Section 620 Report
Enacted in the shadow of the public debate over the Volcker Rule, Section 620 of the Dodd-Frank Act was intended to address activities not covered by the Volcker Rule’s restrictions on proprietary trading and covered fund activities, in particular longer-term risky holdings and trading. Section 620 requires the three federal banking regulators to conduct a study and report to Congress within 18 months of the enactment of Dodd-Frank. The report must address the appropriate activities and investments for banking entities under federal and state law, as well as review and consider (i) the types of permissible activities or investments; (ii) any financial, operational, managerial or reputation risks associated with or presented as a result of the banking entity engaged in the activity or making the investment; and (iii) risk mitigation activities undertaken by the banking entity with regard to the risks. The banking regulators submitted the 620 report on September 8, 2016, over six years after enactment of the statute. The 620 Report is divided into three sections, one for each regulator, covering those entities subject to its supervision:. The Board prepared Section I, the FDIC Section II, and the OCC Section III.
The three regulators have taken markedly different approaches in the 620 Report. Consistent with its approach under the proposed rule, the Board, in Section I of the 620 Report, has made a series of recommendations for legislative repeal of several of the authorities that currently allow banking entities to engage in commercial activities, calling for a greater separation of banking and commerce. The Board’s recommendations all require congressional action.
The OCC, which supervises national banks, federal savings associations, and federal branches and agencies of foreign banks does not recommend legislative action but plans to take action itself, through rulemaking or guidance, to enhance its prudential regulatory scheme. It intends to issue unilaterally rules and guidance that could have a significant and more immediate effect on banks’ asset-backed securities, derivatives, commodities and structured products activities.
The FDIC, which supervises state-chartered insured banks and savings associations, has identified several areas for potential action but has taken the least drastic approach by adopting a wait-and-see posture to consider how certain activities interact with existing and new FDIC regulations and supervisory approvals.
The Board: Section I
The Board’s recommendations in its section of the 620 Report are sweeping, calling for the repeal of authorities and exemptions that currently allow FHCs and SLHCs to engage in a broad range of commercial activities. With respect to banks’ authorities to engage in physical commodities activities, the Board recommends the repeal of the merchant banking and Section 4(o) authorities under the BHCA that had been added by the GLBA.
Repeal of merchant banking authority. As discussed above, under current merchant banking authority, FHCs may make investments in nonfinancial companies as part of a bona fide merchant or investment banking activity, including in any type of nonfinancial company, including portfolio companies engaged in physical commodities activities. In addition, ownership investments in a portfolio company may be in any amount. Current regulations require that corporate separateness be maintained to help ensure the limited liability of the FHC’s investment. Thus, an FHC generally may not participate in the day-to-day management of a portfolio company. FHCs are also required to establish risk management policies and procedures for these merchant banking activities. Under the GLBA, however, an FHC may manage or operate a portfolio company as may be necessary to obtain a reasonable return on the resale or disposition of the investment. According to the Board, this exposes the FHC to increased risks of being liable for operations of the portfolio company (e.g., if the portfolio company were involved in an environmental event). In the Board’s view, its regulatory authority to limit the potential risks to the FHC is not sufficient to manage the safety and soundness concerns, leading the Board to call for the wholesale legislative repeal of merchant banking authority.
Repeal of Section 4(o) grandfathering. The 620 Report also calls for a repeal of the grandfather authority under BHCA Section 4(o). The Board is concerned that this authority raises safety and soundness concerns largely because certain environmental laws impose strict liability on the owners and operators of certain physical commodities facilities for environmental releases or other events. Liability arising from environmental catastrophes can, in the Board’s view, create material financial, legal, reputational and market access harm for these firms. The Board is also concerned that lack of separation between banking and commerce creates a risk of undue concentration that could have a disproportionate effect on financial markets, production and employment if failure occurs. In addition, the Board argues that, because the Section 4(o) authority applies to only two firms, it raises competiveness concerns, including access to important industry-related information to which other FHCs do not have access, such as the amount and timing of production. The Board is also critical of the automatic nature of the Section 4(o) grandfather, which allows a covered company to engage in physical commodities activities without notice to or approval of the Board.
The OCC: Section III
The OCC does not recommend any congressional action in its section of the 620 Report. Instead, it notes its intention to take regulatory action in each of the four areas it reviewed, namely physical commodities, derivatives, securities and structured products. We discuss its approach to physical commodities and derivatives below.
Physical commodities. Like FHCs, national banks currently may buy and sell coin and bullion, which, under OCC precedent, include gold, silver, platinum, palladium and copper. Banks may store these precious metals for themselves and their customers and may transport the metals to or from their customers. Banks may also serve as custodian for an exchange-traded fund that invests in these precious metals. Consistent with the proposed rule issued by the Board, the OCC plans to solicit comment on whether it should treat copper as a base metal rather than as “coin and bullion.” The OCC’s proposal will define “coin and bullion” to exclude copper cathodes and will conclude that buying and selling copper is generally not part of or incidental to the business of banking.
National banks may also buy and sell physical commodities (within limits) to hedge commodity price risk in connection with customer-driven commodity derivative transactions. The 620 Report notes that the OCC published supervisory guidance in 2015 to clarify how national banks should calculate how much of their hedging involves physical settlement so that they remain within the current precedent that requires that physical hedges be no more than 5% of a bank’s hedging activity. The 620 Report notes that this guidance implements the OCC’s recommendation that physical hedging limits be clarified.
National banks may also acquire exposure, up to a limit of capital and surplus, to physical commodities through investment in renewable fuel capital investment companies, up to 5% of capital and surplus and certain investments that promote primarily the public welfare, such as in companies that generate renewable energy. In addition, national banks may acquire physical commodities in satisfaction of a debt previously contracted (e.g., the bank could foreclose on grain collateral pledged for a loan to a farmer). The 620 Report does not contain recommendations relating to these activities.
Derivatives. National banks may enter into derivatives transactions with payments based on bank-permissible holdings (e.g., tied to interest rates, foreign exchange, credit, precious metals and investment securities). With OCC-written non-objection, banks may deal in derivatives on certain other assets if part of customer-driven financial intermediation. National banks may not conduct proprietary trading in these derivatives. The OCC notes that Congress has approved national banks’ ability to offer swaps in connection with originating a loan. However, the OCC is concerned with what it views as smaller national banks’ interest in expanding their swap dealing business, particularly in commodity swaps. In 2014, the OCC enhanced its procedures for examining activities in which the bank enters into derivatives as an end user rather than as a dealer. The OCC now intends to “clarify minimum prudential standards” that apply to national banks engaging in certain swap dealing activities.
The OCC is also reviewing the risks to federal banking entities of the entities’ membership in clearinghouses, particularly where their liability is not capped by the rules of the clearinghouse. The OCC may decide to issue guidance on clearinghouse membership.
Despite substantial input from market participants to the effect that physical commodities activities of banks have been conducted in a safe and sound manner and do not pose a significant potential for catastrophic liability or systemic risk, the proposed rule and the Board’s legislative recommendations in the 620 Report indicate the Board’s ongoing commitment to make significant changes in this area and suggest that the Board is unlikely to be receptive to overall philosophical opposition to its proposed direction. While the Board has previously floated broad ideas on reform, the proposed rule represents the first time the Board has offered specifics on how it intends new limitations to work and an estimate of the market impacts of such proposals. The Board therefore may be more receptive to comments concerning the effects of the specific measures it has proposed, including its estimates of the market impacts from these specific proposals. Comments on the proposed rule must be submitted by December 22, 2016.
The Board’s preferred direction with respect to changes to the BHCA is also clear. However, the impending election makes it impossible to predict the likelihood of legislative movement in this regard.
 An FHC is a bank holding company (BHC) with well-capitalized subsidiaries that, pursuant to the Gramm-Leach Bliley Act (GLBA), may engage in financial activities, including securities underwriting and dealing, insurance activities, and merchant banking activities.
 Notice of proposed rulemaking, Risk-based Capital and Other Regulatory Requirements for Activities of Financial Holding Companies Related to Physical Commodities and Risk-based Capital Requirements for Merchant Banking Investments (Sept. 23, 2016) (hereinafter referred to as “NPRM”); available at https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160923a2.pdf.
 Report to the Congress and the Financial Stability Oversight Council Pursuant to Section 620 of the Dodd-Frank Act (September 2016), available at https://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160908a1.pdf.
 The Board also makes legislative recommendations with respect to other types of activities. It recommends the repeal of (i) the exemption that permits corporate owners of industrial loan companies (ILCs) to operate outside of the regulatory and supervisory framework applicable to other corporate owners of insured depository institutions; and (ii) the exemption for grandfathered unitary savings and loan holding companies (SLHCs) from the activities restrictions applicable to all other SLHCs.
 Complementary Activities, Merchant Banking Activities, and Other Activities of Financial Holding Companies Related to Physical Commodities, 79 Fed. Reg. 3330 (Jan. 21, 2014). In response to the notice, critics of bank involvement in commodities argued that financial holding companies participating in these markets had an unfair competitive advantage, presented serious conflicts of interest and, most important, exposed the financial system to serious risk in the event of a catastrophic event. They believed that further regulation would help mitigate these risks, thereby protecting the financial system. Citing benefits such as increased convenience and competition, efficiency gains, more readily available liquidity, and lower commodity prices, proponents of bank involvement in physical commodities claimed that financial holding companies provide valuable services to end users, such as municipalities, that would be difficult to replace in the event of stricter regulation that might preclude banks from participating in physical commodities activities. Proponents pointed to the robust risk management processes that banks have established to ensure the safety of physical commodities activities, and further cited the sound safety record to date as evidence that these activities do not pose undue risks to financial holding companies or the financial system.
 Wall Street Bank Involvement with Physical Commodities: Hearing before the Perm. Subcomm. on Investigations of the S. Comm. on Homeland Sec. and Governmental Affairs, 113th Cong., 2d Sess. (Nov. 2014) (testimony of Gov. Tarullo).
 In general, the amount of capital an institution subject to capital requirements is required to hold is calculated by multiplying the minimum capital adequacy ratio (e.g., 4% or 8%) by the risk-weighted asset exposures. Thus, for example, if the minimum capital adequacy ratio is 8%, a risk weight of 1,250% applied to the market value of section 4(o)-permissible commodities would mean that for these activities the FHC would be required to hold an amount of capital equal to the total market value of the commodities held under that authority.
 The proposal provides for an FHC to use daily averages for physical commodities quantities and rolling month-end, end-of-day spot prices over a 60-month period to determine the market value of its covered physical commodities. NPRM, at p. 32.
 Id., at pp. 31–32.
 Id., at p. 25.
 Id., at p. 27.
 The proposal would exclude from the cap the physical commodities activities of portfolio companies held under the merchant banking authority, assets related to the satisfaction of debts previously contracted and insurance company investments held under BHCA § 4(k)(4)(I).
 Examples of such other authorities cited by the Board are the authority for certain national banks to hold physical commodities to hedge customer-driven, bank-permissible derivative transactions, and the authority to possess physical commodities provided as collateral in satisfaction of debts previously contracted in good faith. NPRM, at p. 20.
 Id., at p. 23.
 Id., at p. 42.
 Id., at p. 30.
 The proposal calls this the “section 4(k) cap parity amount,” which excludes commodities owned pursuant to the merchant banking authority, similar insurance investment authority, and authority to acquire assets and voting securities in satisfaction of debts previously contracted.
 NPRM, at p. 27.
 Id., at p. 46.
 Memorandum from Staff to Board of Governors, Re: Proposed Rule Implementing Strengthened Prudential Requirements, including Risk-based Capital Requirements for Physical Commodity Activities and Investments of Financial Holding Companies, at p. 2.
 NPRM, at pp. 34–35.
 Id., at p. 34.
 Id., at p. 35.
 See 156 Cong. Rec. S5895 (July 15, 2010) (statement of Sen. Merkley).
 The three federal banking regulators are the Board, the Federal Deposit Insurance Corporation (FDIC) and the OCC.
 Specifically, the OCC plans to:
- issue a proposed rule that restricts national banks from holding as type III securities asset-backed securities, which may be backed by bank-impermissible assets, and to issue an analogous proposed rule for federal savings associations;
- address concentrations of mark-to-model assets and liabilities with a rulemaking or guidance;
- clarify minimum prudential standards for certain national bank swap dealing activities;
- consider providing guidance on clearinghouse memberships;
- clarify regulatory limits on physical hedging;
- address national banks’ authority to hold and trade copper; and
- incorporate the Volcker Rule into the OCC’s investment securities rules.
 The Board also recommends the repeal of the exemption that allows corporate owners of ILCs to operate outside of the regulatory and supervisory framework applicable to non-ILC corporate owners and the exemption for grandfathered unitary SLHCs from activities restrictions applicable to other SLHCs.
 Since the FDIC did not make any recommendations, we do not discuss Section II of the Report.
 OCC Bulletin 2015-35, “Quantitative Limits on Physical Commodity Transactions” (Aug. 4, 2015).
 620 Report at 86.
As the country recovers from the shock outcome of last Thursday’s Referendum, the question which Restructuring professionals must now consider is “what does Brexit mean for me?”. The truth is that nobody really knows. The Referendum decision is not legally binding on the UK Government and the process of the UK leaving the EU will only start once the UK has served formal notice on the EU pursuant to Article 50 of the Treaty on the European Union. This will start a two year negotiation period to effect Brexit. In the meantime, the UK remains a member of the EU and EU law continues to apply.
So, in some respects it is very much business as usual for now, but on the basis that David Cameron’s successor will give notice to leave the EU, we recommend that clients start considering the consequences of Brexit now. Preparation for those consequences may include looking at the following:
Contract Reviews – Many contracts refer to an array of EU laws, regulators and territories which should be reviewed to determine how Brexit may/will impact. Can the contract be varied to mitigate the impact of Brexit? What is the potential impact on the contract price being linked to Sterling, the Euro or the Dollar? Does the governing law clause need amending? Will Brexit result in a breach of contract? Whilst unlikely, can force majeure or material adverse effect clauses be relied upon? How can the contract be future-proofed?
Financing and security reviews – Brexit caused turmoil in the markets initially and led to a reduction in the UK’s credit score rating and a significant devaluing of sterling. Before the Referendum, warnings of a post Brexit recession were rife. Is your business/customer at risk of breaching its financial covenants as a consequence of Brexit? Do those facilities and security need to be reviewed and changes made to protect the position?
Vulnerability to Brexit – Brexit is going to impact some more than others. How much do you or your clients/customers trade with other EU countries? How will your supply chain be affected? Do you currently benefit from EU funding? Is the tax efficiency of your business based on EU law? Does your business benefit from EU emission allowances? Will you need a licence or other authorisation to trade in the EU?
Public Policy – The UK will have to review where domestic legislation may need to be amended to take account of Brexit. It will be important to businesses to understand what changes are likely to be coming down the line. Many of the legal changes will be driven by policy decisions made in London and/or Brussels in particular. Keeping on top of these Policy decisions may allow businesses to position themselves to benefit from or at least mitigate the effects of legislative change. Do you need to engage with public policy professionals to assist in lobbying for changes which will have a positive impact on your business?
International Trade Arrangements – To what extent does your business involve the supply of goods between the UK and other EU member states? How will your business be impacted by the potential imposition of tariffs and other trade barriers restricting the free movement of goods post-Brexit?
Immigration and employment– What nationality are your employees? How will your ability to recruit/second employees be affected and will any parts of your business have to be downsized?
Communication – To what extent do you need to make any public statements or disclosures in relation to the impact of Brexit on your business. What is your strategy for communicating the impact of Brexit with your staff?
Other issues will arise as the full impact of Brexit unravels over the coming weeks and months.
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